Subsidizing the "fake fall"? Tokyo inflation plunges to a four-year low, Japan's central bank's June rate hike plan shrouded in uncertainty.

Notice that the core inflation index in Tokyo unexpectedly slowed to its slowest pace in four years, making the policy communication of the Bank of Japan more complicated, but not necessarily derailing market expectations of an interest rate hike as early as next month. Data released by the Japanese Ministry of Internal Affairs on Friday showed that the consumer price index (CPI) in Tokyo, excluding fresh food, rose by 1.3% year-on-year in May. This marks the sixth consecutive month of deceleration for this index and is lower than all economists' forecasts except for one. Meanwhile, the index excluding fresh food and energy - a key indicator closely watched by the Bank of Japan to measure underlying inflation trends - rose by 1.6%. This index, which excludes interference from government subsidies, is considered to more cleanly reflect price trends. However, due to last year's unprecedented surge in prices of goods like rice, this index is still affected by some food price base effects. Overall CPI rose by 1.4% year-on-year. The Tokyo CPI is typically seen as a leading indicator of national price trends. The slowing increase in processed food prices compared to last year, as well as a significant decrease in water service charges, had a suppressing effect on this CPI. Thanks to Prime Minister Sanae Takaichi's implementation of gasoline subsidies, energy prices continued to fall. Takaichi plans to submit a supplementary budget to parliament soon to maintain these subsidy measures. The report indicates that the government's plans to successfully mitigate living costs have also obscured potential inflation trends. In addition to water fees, the Tokyo Metropolitan Government has taken measures to reduce early childcare costs - including daycare fees, which have seen a significant decrease. Some of these measures have also distorted the national CPI, resulting in the slowest increase in national CPI in four years in April. Bank of Japan policymakers remain vigilant about the price rebound caused by the Iran war. This should provide them with room to push for an interest rate hike at their next monetary policy meeting on June 15-16. According to overnight indexed swap (OIS) data, as of Friday morning, traders predict a probability of around 77% for a rate hike at this meeting. Economist Taro Kimura said, "We believe the Bank of Japan will see through the weakness in the overall data and remain vigilant about the inflation upside risks from rising oil prices. We continue to expect the Bank of Japan to raise rates by 25 basis points to 1% in June." As a key indicator of demand-driven inflation, service prices rose by 1.1% year-on-year. Food prices excluding fresh food rose by 4.1%, with a slower pace of increase compared to the previous month. Rice prices fell by 1%, marking the first decline since August 2022 and a far cry from the nearly 94% surge last year. Takaichi recently called for funding through a supplementary budget to support utility subsidies this summer, and earlier this week, she said this funding would be raised without increasing the issuance of government bonds. Nevertheless, concerns about expanding fiscal expenditures persist in the market. Together with the general rise in yields due to concerns about inflation triggered by war globally, this has led to a sell-off of Japanese government bonds. The Prime Minister also does not hide her preference for loose policies. Takaichi told Kazuo Uteda last week that she hopes the Bank of Japan can take into account the government's price relief measures and other economic measures when formulating appropriate monetary policy. As inflation risks outside of war rise, challenges may arise. Major food manufacturers in Japan, Nippon Flour Mills and Showa Sangyo, announced on Thursday that they will raise prices of some products starting in August. These moves indicate that companies are becoming more willing to pass on higher costs to consumers, a trend that Uteda has also noted. The yen is another factor contributing to persistent price pressure due to the higher cost of imported goods. As of 9:36 am on Friday, the yen was trading near 159.30 against the US dollar, still close to the lowest level since the Japanese Ministry of Finance intervened in the exchange rate on April 30. The latest intervention data will be released later on Friday. Two other data released on Friday showed that industrial output unexpectedly rose for the first time since the beginning of the year in April, and retail sales also rebounded from the previous month. Japan's unemployment rate fell to 2.5% last month, the lowest level since July of last year.